Wednesday, 15 August, 2007

Subprime mess is not a global crisis: S&P

International rating agency Standard & Poors (S&P) has said the current problems with the subprime market will not precipitate a crisis in the financial markets. The rating agency has said safety valves in the financial system after the earlier Asian crises would prevent a global fallout. However, subprime defaults do have downside as they have shrunk market for collateralised debt obligations (CDOs), which could mean lesser flexibility for highly leveraged companies.

According to S&P, the prevalence of mark-to-market accounting, credit default swaps and other tools of finance allow risk to be repriced quickly as conditions change. “This rapid repricing, paradoxically, tends to aggravate short-term instability. But drawing attention to problems as they emerge forces managers to restructure troubled portfolios or entities before danger can reach explosive proportions and threaten a broad-based implosion of credit quality,” S&P said in a report titled ‘Putting Today’s Credit Market Risks In Perspective’.

The report comes at a time when global equity markets have been rattled over major defaults in subprime housing loans in the US. Some market participants are speculating that the difficulties in the US subprime mortgage market may yet spill over into other markets and lead to a more general deterioration in credit quality. Marketmen, who have been around since the Asian crisis in 1997, feel that the contagion may spread across countries as it did in the 1990s.

The Asian financial crisis wreaked havoc on regional economies and set into motion a far-ranging series of events that included currency dislocations, the Russian default, and, eventually, the collapse of Long Term Capital Management, a major hedge fund whose core backers included large financial institutions in the US and Europe. “There is presently no concrete evidence to suggest that problems in the subprime mortgage market will reach the magnitude experienced during these earlier crises, much less that they will evolve into more general or severe systemic instability. But it is also not possible to say with certainty that the problems are fully contained,” said S&P.

Modern markets adjust rapidly

“We believe some spillover is likely — and is already occurring to a limited extent — but we think it is important to keep the current situation in perspective when attempting to gauge the risk that widespread troubles will extend to other markets,” said S&P in its report. Pointing out to lessons from the past 20 years, the rating agency highlighted that although instability in one market can quickly spread to others, these experience from earlier crises show that modern markets adjust rapidly to crises and tend to limit the damage before uncontrollable systemic disruption takes hold. “The global markets have grown such that they are now less vulnerable to general liquidity scares triggered by isolated disruptions,” S&P said.

Comparing the problems with the subprime market to the corporate defaults in 2001, the report said despite corporate defaults touching their highest levels in decades during the 2001 recession, no major financial institutions were threatened, and the general economic recession proved to be relatively mild.

While being optimistic of a limited impact of the subprime problem, the report acknowledges that far-flung banks have been affected. “The effects of the turmoil in the US mortgage markets have already made themselves felt elsewhere; the widely publicised problems at two bond funds managed by US investment bank Bear Stearns have reverberated in other parts of the world.

In Australia, funds managed by Macquarie Bank, Basis Capital, and Absolute Capital Group have suffered severe losses, and the German bank IKB Deutsche Industriebank has forced its CEO to resign, all because of exposure to the US subprime mortgage market. No one can rule out the possibility that more such incidents will surface before the global markets have fully digested these exposures.”

Via Economic Times